Friday, August 1, 2008

The light at the end of the tunnel: the GDP report was not all that bad!

Yesterday, the Bureau of Economic Analysis (BEA) reported that second quarter (Q2) growth in Gross Domestic Product (GDP), a measure of total production, was estimated to be 1.9%. Further, it downgraded Q4 2007 growth from +0.6% to -0.2%. Since Q2 growth was reported lower than economists had expected and Q4 growth is now negative, the media jumped on the opportunity to highlight the bad news and dispense of the good news.

The first two paragraphs of the pessimistic New York Times article, More Arrows Seen Pointing to a Recession, are:

“The American economy expanded more slowly than expected from April to June, the government reported Thursday, while numbers for the last three months of 2007 were revised downward to show a contraction — the first official slide backward since the last recession in 2001.
Economists construed the tepid growth in the second quarter, combined with a surge in claims for unemployment benefits, as a clear indication that the economy remains mired in the weeds of a downturn. Many said the data increased the likelihood that a recession began late last year.”

Actually, the GDP report was rather positive

Is it time to throw in the towel? All of the negative commentary (in blue) does put one in a melancholy mood. However, the BEA report was not all that bad for three reasons:
1. Changes in inventories were a big drag on growth – this component of GDP will likely be a positive contribution to growth next quarter.
2. 1.9% annualized growth is remarkable given the headwinds that the economy faces.
3. Export growth is strong and the wane from housing is diminishing.

Private investment (residential plus nonresidential) dragged growth down -2.28% in Q2, where changes in inventories accounted for most of the drag, -1.92%. Firms sold their already produced goods and services, or inventories, which cannot be counted as current production. Going forward, firms will need to produce again because the inventory stock is now so low, and production will rise in Q3. What would have been 1%-1.5% growth in Q3 is now expected to be 1.3%-1.9%. Isn’t that a good thing?

As Pres. Bush said, “We got some positive news today.” Certainly, 1.9% is below the expected 2.3%; however, in the last five recessions, there has never been a quarter of 1.9% annualized growth! Actually, the 2001 recession (March through November) is the only recession that marked positive growth at all.
That is why the media is harping on the Q4 2007 estimate of growth; most recessions exhibit negative growth, so all of the pessimists now have negative growth in their pile of bad news.

However, the NY Times article fails to mention that job growth was positive during Q4 2007, averaging +80,000 additional jobs per month. It is very unlikely that the National Bureau of Economic Research (NBER), the committee responsible for dating the recession, will call a recession if the labor market was expanding.

Export growth is strong. Exports are growing 4-5 times GDP growth, which has added substantially to overall U.S. growth. The NY Times article correctly surmises that export growth will decelerate as economies around the world slow. However, just as exports slow the housing market will pick up. Housing (residential structures) is currently just 3% of GDP (exports are almost 13% of GDP), and still, housing reduced Q2 growth by -0.62%. The housing market is expected to rebound in early 2009, and its drag from growth will be eliminated. GDP will grow closer to potential.

Today’s labor market report

Today’s labor report will offer another piece of the recession puzzle; there has never been a non-recession period with seven consecutive months of labor market contraction (payroll growth is negative). If today’s numbers post serious losses, it may be time to throw in the towel and call a recession. But still, one cannot argue that the economy has been quite resilient in the face of severe headwinds.

As I argue (and this argument still holds today), the verdict is not in. There are several statistics that are not showing clear signs of contraction – personal income, industrial production, and retail sales. It certainly does not look good, but it is not overly obvious that the overall economy is contracting.

A final note on GDP

GDP is subject to major revisions for years to come. Next month, GDP may be revised up or down, and then next year it may be further revised. Dating a recession is a long process; the verdict will not be in for at least a year or so. The NBER dated the 2001 recession in 2003.

Please leave comments. Best, Nontruths

1 comment:

  1. Thanks for the positive thoughts to counter the NY Times. It really is the political slant of the reports that comes through and not a reasoned approach. And, it is SO obvious! Love when the markets go UUUP and DOOOOWN like they are now. One sits on the sidelines, watches people behaving idiotically and laughs.